The perils of an uneven global recovery

Kenneth ROGOFF

Economic recovery, like COVID-19 vaccines, will not be evenly distributed around the world over the coming two years. Despite enormous policy support provided by governments and central banks, the economic risks remain profound, and not just to frontier economies facing imminent debt problems and low-income countries experiencing an alarming rise in poverty. With the coronavirus far from tamed, populism rife, global debt at record levels, and policy normalization likely to be uneven, the situation remains precarious.

This is not to deny the overall good news of the last 12 months. Effective vaccines have become available in record time, far sooner than most experts originally anticipated. The massive monetary and fiscal response has built a bridge toward a much-hoped-for end to the pandemic. And the public has gotten better at living with the virus, with or without the help of national authorities.

But although growth outcomes around the world have been vastly better than most expected in the early days of the pandemic, the current recession is still catastrophic. The International Monetary Fund forecasts that the United States and Japan will not return to pre-pandemic output levels until the second half of this year. The eurozone and the United Kingdom, again declining, won’t reach that point until well into 2022.

The Chinese economy is in a league of its own, and is expected to be 10% larger by the end of 2021 than it was at the end of 2019. But at the other end of the spectrum, many developing economies and emerging markets could take years to return to their pre-pandemic trajectories. The World Bank estimates that the COVID-19 pandemic will push up to 150 million additional people into extreme poverty by the end of 2021, with food insecurity rampant.

The differing performance projections have much to do with the vaccine delivery timetable. Vaccines are expected to be widely available in advanced economies and some emerging markets by the middle of this year, but people in poorer countries will likely be waiting until 2022 and beyond.

Another factor is the staggering difference in macroeconomic support between rich and poor countries. In advanced economies, additional government spending and tax cuts during the COVID-19 crisis have averaged nearly 13% of GDP, with loans and guarantees amounting to another 12% of GDP. By contrast, government spending increases and tax cuts in emerging economies have totaled around 4% of GDP, and loans and guarantees another 3%. For low-income countries, the comparable numbers are 1.5% of GDP in direct fiscal support and almost nothing in guarantees.

In the run-up to the 2008 financial crisis, emerging economies had relatively strong balance sheets compared to developed countries. But they entered this crisis burdened with far more private and public debt, and are thus much more vulnerable. Many would be in deep trouble but for near-zero interest rates in advanced economies. Even so, there has been a growing rash of sovereign defaults, including in Argentina, Ecuador, and Lebanon.

In fact, a “taper tantrum 2.0” is near the top of the list of things that can go wrong, and if (or when) it happens, not only emerging markets will suffer. The 2013 taper tantrum occurred when the US Federal Reserve started signaling that it would someday normalize its monetary policy, triggering huge outflows of funds from emerging markets. This time, the Fed has taken great pains to signal that it does not plan to raise interest rates for a long time, even introducing a new monetary framework that basically amounts to a promise to keep its foot on the gas until unemployment is extremely low.

Such a policy makes perfect sense. As I have frequently argued since 2008, allowing inflation temporarily to rise above the Fed’s 2% target would do far more good than harm in an environment where debt levels are high and output is still below potential. After all, there are nine million fewer people working in the US today than a year ago.

But if the US has achieved its vaccination targets by this summer and coronavirus mutations remain contained, forecasts of a Fed “lift-off” from zero interest rates may well be brought forward significantly. This is especially likely given the huge reserve of savings that many Americans have built up, owing partly to rising asset prices and partly to government transfers that many recipients chose to save.

Ultra-low interest-rate policies across the world are helping to prevent long-term scarring, but many larger companies, including Big Tech firms, do not need the support that is driving their stock prices through the roof. This is inevitably fueling populist anger (a small taste of which was evident in some US politicians’ reactions to the recent GameStop stock-price war).

Inflation may be stubbornly low for now, but a big enough blast of demand could push it higher, leading the Fed to raise rates somewhat sooner than it currently plans. The ripple effects of such a move on asset markets would separate the strong from the weak, and hit emerging markets particularly hard. At the same time, policymakers, even in the US, will eventually have to allow bankruptcies to pick up and restructuring to take place. A rising tide of recovery is inevitable, but it will not lift all boats.

Kenneth Rogoff, a former chief economist of the International Monetary Fund, is Professor of Economics and Public Policy at Harvard University.

Copyright: Project Syndicate, 2021.

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